This study examines the usefulness of an analyst-based valuation model in predicting cross-sectional stock returns. We estimate firms' fundamental values (V) using I/B/E/S consensus forecasts and a residual income model. We find that V is highly correlated with contemporaneous stock price, and that the V/P ratio is a good predictor of long-term cross-sectional returns. This effect is not explained by a firm's market beta, B/P ratio, or total market capitalization. In addition, we find errors in consensus analyst earnings forecasts are predictable, and that the predictive power of V/P can be improved by incorporating these errors.

Recent studies have provided theory and evidence that the contemporaneous relation between stock returns and accounting earnings is nonlinear, different for profits and losses, and different across firms. Since each factor can result from differences in earnings persistence, existing theory is ambiguous as to whether these factors are distinct or overlapping. Thus, we conduct a simultaneous examination. Our primary tests show that each factor explains a significant portion of the variance of returns after controlling for the other two factors, with firm-specific estimation providing the largest incremental explanatory power. Alternative tests produce similar conclusions. Empirically, the three factors are distinct.